Understanding Overhead Recovery Rate in Construction

In building, knowing your expenses is only half the battle. Allocating overhead expenditures correctly is critical if you want to protect your margins and bid profitably. The overhead recovery rate is an essential, although frequently misunderstood, measure in this domain.

In this article, we will explain what the overhead recovery rate is, how to calculate it, and why getting it right is critical for business success. We'll also look at typical contractor questions and give ideas from our years of real-world construction accounting expertise.

What Is Overhead Recovery Rate?

The overhead recovery rate is a way to spread secondary costs, or costs that aren't directly related to a project, among your jobs. Some of these are rent, office pay, insurance, tools, the wear and tear on equipment, and more.

Overhead costs aren't easily tied to a specific job or phase of building like direct costs are, like labor and materials. But failing to get those costs back through right pricing can have a big effect on profits.

Read more: Are You Spending Too Much? Understanding Construction Overhead Costs

Why Overhead Recovery Matters in Construction

Most builders know how to keep track of how much materials and labor cost. But if you don't think about building overhead costs, you might not charge your clients enough, which will cut into your profits without you even realizing it.

Here's why it's important to get your overhead selection methods right:

• Ensures accurate job costing in construction

• Prevents underpricing bids

• Helps assess contractor job profitability

• Supports better financial planning and budgeting

• Provides insight into operational efficiency

What Counts as Overhead in Construction?

Overhead expenses can be divided into two categories: fixed and variable.

Fixed Overhead Costs	Variable Overhead Costs
Office rent	Fuel and travel expenses
Salaries of office staff	Temporary utilities or internet
Business insurance	Project management expenses
Equipment depreciation	Tools and equipment rental

Understanding the breakdown between fixed vs variable overhead can help you decide how to allocate them properly.

Read more: Fixed vs. Variable Overhead in Construction: What’s the Difference?

How to Calculate Overhead Recovery Rate

You can find and use your cost recovery rate in a number of different ways. The way you pick should fit your business, the types of jobs you do, and how you set your prices consistently. 

Method 1: Percentage of Direct Costs

This is the most common method. Overhead is applied as a percentage of direct costs (labor, materials, etc.).

Formula:

Overhead Rate (%) = (Total Overhead Expenses ÷ Total Direct Costs) × 100

For example, if your annual overhead is $200,000 and your total direct costs are $800,000, your overhead recovery rate is: ($200,000 ÷ $800,000) × 100 = 25%

You can then apply this 25% to each job's direct cost total to recover overhead proportionally.

Method 2: Labor Burden Rate (Burden Rate Construction)

This method allocates overhead based on labor hours or costs.

Burden Rate = (Overhead ÷ Total Labor Cost)

This is ideal if labor is your biggest expense. It allows you to estimate project overhead more accurately based on the hours worked.

Method 3: Per Hour or Per Unit Cost Allocation

In this method, you spread your overhead across billable labor hours or units completed.

This works well for service contractors or companies that use standard pricing based on hours or square footage.

Common Questions Contractors Ask

Is overhead the same as markup?

Not quite. Markup is the amount you add to your overall costs (direct costs plus overhead costs) to get the profit you want. Overhead costs, on the other hand, are real business costs that need to be recovered, just like supplies or labor. If you don't know the difference between building markup and margin, you could undervalue your costs or overvalue jobs.

How do I track my overhead in QuickBooks?

To track construction expenses effectively in QuickBooks:

• Create expense accounts for all indirect costs

• Categorize them consistently (office, utilities, insurance, etc.)

• Use job costing tools to separate direct vs indirect costs

• Set up class tracking or locations to see company-wide overhead

Some contractors even create a custom job costing formula in QuickBooks that incorporates allocating overhead in QuickBooks to each project based on the chosen method.

Tips to Improve Overhead Recovery

• Update Overhead Calculations Regularly: Don’t use outdated numbers. Rising fuel, insurance, or rent costs can skew your recovery rate.

• Review Job Cost Reports Frequently: Use construction job cost analysis reports to evaluate actual costs vs estimates.

• Separate Direct and Indirect Costs Clearly: Maintain discipline in coding expenses properly in your accounting software.

• Use Technology for Accuracy: Cloud-based accounting platforms allow for real-time data entry and tracking of indirect costs in construction.

When Should Contractors Seek Professional Help?

Using spreadsheets or accounting tools, you might be able to figure out your own overhead recovery rate. But as your business grows, things get more complicated. Here are some signs that it might be time to get help from a professional:

• You struggle to keep up with regular cost reviews

• You’re unsure if you’re underbidding or overcharging

• You can’t confidently separate overhead from job costs

• You’re not using job costing features in your accounting system

In such cases, accurate accounting becomes too important to leave to chance.

How Construction Cost Accounting Can Help

It's normal to wonder, "Do I have the time and resources to manage this regularly?" once you know how to keep track of and figure out overhead.

That's where we at Construction Cost Accounting come in handy. We focus on building bookkeeping services that help with accurate job costing, allocating overhead costs, and making money in the long run. If you're doing it yourself, you should start by clearly separating your expenses into groups. Then, choose a way of recovery that works for your business and use financial software to make sure you stick to it.

But hiring a construction-specific accountant partner can be a good idea if you want to save time, cut down on mistakes, and make sure you're following industry standards. 

Conclusion

Getting the right overhead recovery rate isn't just important for accounting; it's also important for the growth of your business. By getting back the correct amount of building overhead costs, you can bid with confidence and protect your profit margins.

The most important thing is to get your costs under control before they take over your business. You can do this by managing them yourself or by hiring a company like Construction Cost Accounting to help you.